Description

Primo Water (“PRMW” / www.primowater.com) is a severely broken IPO that is now so largely mispriced as to present an unusually compelling opportunity to compound one’s investment quickly as the dust settles and the attractiveness of the business, current business/new customer momentum and investment situation become clear.  At its present trading price of $1.36/share, PRMW has a market cap of $32mm and TEV of $47mm, down from $246mm and $269mm, respectively, on the day of its IPO (11/5/2010).  Presently, PRMW trades at 0.79x its TBV of $1.73/share, 0.22x its BV of $6.18/share and 3.9x the mid-point of management’s recently reiterated 2012 EBITDA guidance.  These metrics would indicate that the company is in decline or that debt default is imminent, although in reality the company is growing quickly, adding new customers (certain of which have not yet been publicly identified) and has recently refinanced its debt to provide substantial runway for growth.  Aggressive recent insider purchases of both shares and last-out piece of a new term loan by the Founder/CEO, CFO and directors support the thesis and closely align insiders with shareholders.  Finally, PRMW has a high and rising short interest, making squeeze potential quite high.

Note: While PRMW is a micro-cap name, it has reasonable liquidity with 390,000 shares/day of volume over the last 3 months.

Background:

• PRMW, based in Winston-Salem, NC, was founded by Billy Prim, who serves as PRMW’s Chairman, CEO and President.  Previously, Prim founded Blue Rhino Corporation, a propane cylinder exchange business in 1994, led its IPO in 1998 and successful sale for $338mm to Ferrellgas in 2004.  PRMW’s CFO, Mark Castaneda, was CFO and a director of Blue Rhino until its sale in 2004, and rejoined Prim at PRMW in 2008.

• With PRMW, Prim is seeking to replicate the Blue Rhino razor/razorblade business model, but on a far larger scale and with water (3- and 5-gallon purified bottled water), water dispensers and carbonated beverage appliance products.  As of 3/31/2012, PRMW sold into 24,100 combined* retail locations in the U.S. and Canada to customers including Lowe’s, Walmart, Kroger, Safeway, Albertsons, Winn Dixie, H-E-B Grocery and Walgreens.  See below regarding unannounced new customers.
  • Note that locations that sell dispensers, refill bottles and exchange may be double counted.

• Large TAM:  The U.S. bottled water industry is estimated at $11bn in wholesale sales or ~6.5bn gallons, comprised of off-the-shelf at retail, packaged and delivered to homes/offices, and water sold through vending machines.  Vended water eliminates two principal cost components: (i) packaging, because consumers provide their own containers, and (ii) transportation.

• PRMW completed its IPO on 11/5/2010, selling 9.6mm shares at $12.00 and raising net proceeds of $104.7mm.

• Proceeds from the IPO were used primarily to acquire Culligan’s Water Refill Business, which closed five days after the IPO on 11/10/2010.  The purchase price of $105.3mm consisted of $74.3mm in cash and $31.0mm of stock (2.6mm shares @ $12.00/share).
  • For the LTM 6/30/2010, Culligan’s Refill Business generated $25.9mm of sales, $12.4mm of GP (48% margin) and $9.4mm of EBITDA (36% margin). 
  • The cash purchase price represented 7.9x EBITDA and the total purchase price using shares valued at $12.00 represented 11.2x EBITDA.
  • At acquisition, Culligan had 4,500 retail locations in US (84%) and Canada (16%) and customers included Walmart, Safeway, Meijer, Sobeys, Target, Hy-Vee and Kroger.

• Since the IPO, the company has entered the Home Beverage business to compete with SodaStream
  • Acquired Omnifrio Single-Serve Beverage Business on 4/11/2011 for $2mm of cash plus 501,080 shares of stock and deferred cash payments of $1.6mm in 2012 and $3.0mm in 2013.
  • Announced on 11/29/2011 a partnership with SDS, a company founded by Serge Bueno, who previously launched SodaStream in Europe.  This allows PRMW to sell SDS’s vast array of products (Flavorstations) without significant capital investment. Press releases here: http://ir.primowater.com/releasedetail.cfm?ReleaseID=627769 and http://files.shareholder.com/downloads/ABEA-573CPD/1959769169x0x549188/e8920300-dc51-4272-82ef-0a9c990c1024/PRMW_News_2012_3_5_General_Releases.pdf

Why Now / Why Does Opportunity Exist:

• The shares have fallen 89% from the IPO price, leaving the stock massively undervalued at $1.36.
  • 0.79x TBV of $1.73/share
  • 0.22x BV of $6.18/share
  • 3.9x the mid-point of management’s recently reiterated 2012 Adjusted EBITDA guidance of $11-13mm
  • 0.39x the mid-point of management’s recently reiterated 2012 Net Sales guidance of $118-126mm
  • The TEV of the company is now 55% less than the total amount paid for Culligan (cash + stock) less than two years ago.
  • For the LTM Q1 2012, PRMW’s water business alone generated $21 million of EBITDA.  This is masked by operating losses from the Dispenser segment, Flavorstation segment, Corporate segment, acquisition expenses and interest.
  • Déjà vu sidenote: Blue Rhino priced its IPO at $13.00 in May 1998, fell to a low of $2.19 in February 2001 before recovering quickly and ultimately being sold to Ferrellgas for $17.00/share (1.5x LTM Revenue, 11.3x LTM EBITDA) in February 2004.

• The company has missed earnings and/or reduced guidance in recent quarters.
  • In Q2 2011, PRMW’s rollout to certain large retail customers (Walmart in particular) was delayed as these rollouts were to be coupled with “Action Alley” promotions, and these Action Alleys had excess inventory from other retailer customers that took longer than expected to clear out.  This was simply a timing issue.
  • In November 2011, PRMW said that it would effectively miss the Q4 selling season for Flavorstation (Primo’s soda product) due to a delay in getting the flavor formulations right.
  • Subsequent class action lawsuit filed against PRMW, IPO underwriters and certain board members.
  • These issues should now be behind the company.  Per Billy Prim on May 8, 2012 call: “Last year, we were late getting new products into retailers to meet holiday sales period in 2011 and key promotions of these products were delayed.  At the same time, we incurred increased raw material costs that affected the cost of production and distribution of our products.  The combination of these events interrupted our ability to finance our growth.  As we entered the second quarter, I am pleased to report that we have now addressed our key challenges and issues and look forward to continuing our growth of our business.”

• On May 2, 2012, PRMW announced that it refinanced its debt with a new $20mm asset-based revolver from TD Bank and a $15.2mm term loan with warrants from Comvest Capital ($14.0mm) and individuals including Billy Prim and two PRMW board members ($1.2mm) who purchased “last-out” participation interests in the term loan.
  • Revolver with initial 3.5 year term priced at L+3.25% to L+3.75%, depending on excess availability
  • No amortization Term Loan with bullet maturity on 4/16/2016 and priced at 14% cash, 2% PIK plus warrants for 1.6mm shares struck at $2.30 and expiring 4/30/2020; rate reduces to 13% all-cash when PRMW’s Adjusted LTM EBITDA reaches $10mm.
  • Prepayment penalty on term loan of 7% in year 1, 4% in year 2, 2% in year 3; however, if stock price >$4 for each day during prior 60 day period, penalty reduced to 2% in year 2 and 1% in year 3.
  • While seemingly expensive, this financing accomplished three important things:
    • Added substantial liquidity and “runway” for growth without dilution at the current share price, virtually eliminating the risk of near-term secondary offering
    • Provided a path to a significant interest rate reduction
    • Illustrated strong insider commitment to PRMW by their willingness to participate in large dollar amounts and with a “last-out” provision – i.e. if the loan is ever impaired it is likely they recover nothing

• Substantial ownership and aggressive open market purchases of PRMW shares by management and directors:
  • • Billy Prim (Chairman & CEO): owns 2.4mm shares
      • Purchased 10,000 shares @ $1.36 on 5/16/2012
      • Purchased $250,000 last-out participation in term loan on 4/30/2012
      • Purchased 20,000 shares @ $2.99 on 12/14/2011
      • Purchased 20,000 shares @ $4.82 on 8/15/2011
    • Mark Castaneda (CFO): owns 133,471 shares
      • Purchased 10,000 shares @ $1.15 on 6/8/2012
      • Purchased 10,000 shares @ $1.32 on 5/16/2012
      • Purchased 16,300 shares @ $1.45 on 5/11/2012
      • Purchased 5,000 shares @ $3.91 on 8/19/2011
      • Purchased 10,000 shares @ $4.71 on 8/15/2011
    • Malcolm McQuilkin (Director, CEO of Uniflame, CEO of Blue Rhino Global Sourcing): owns 313,607 shares
      • Purchased $500,000 last-out participation in term loan on 4/30/2012
      • Purchased 50,000 shares @ $3.52 on 11/11/2011
      • Purchased 12,500 shares @ $5.03 on 8/26/2011
      • Purchased 87,500 shares @ $4.73 on 8/25/2011
    • Jack Kilgore (Director, President of Rich Products’ Consumer Brands Division): owns 30,567 shares
      • Purchased 5,000 shares @ $1.46 on 5/11/2012
      • Purchased $50,000 last-out participation in term loan on 4/30/2012
      • Purchased 5,000 shares @ $2.90 on 12/7/2011
      • Purchased 10,600 shares @ $4.92 on 8/15/2011

• Recent price increases should drive increased margins in both Water and Dispensers.  Per Billy Prim on May 8, 2012: “We've increased prices on our products and as a result, expect an increase in our margins in both Water and Dispensers. We are pleased that the first quarter gross margin increased significantly from the fourth quarter of last year. The balance of our price increases go into effect June 1, which provide us with solid visibility of our margin rate in the second half of this year.”

• Recently implemented $2mm+ of cost reductions.  Per Billy Prim on May 8, 2012:  “We reduced expenses by more than $2 million on an annual basis to streamline our business and increase our overall operating efficiencies.  These changes were difficult but a necessary step forward.  We now believe we are positioned for profitable growth in the second half of this year.  We have confidence in our $11 million to $13 million EBITDA number for outlook for 2012.”

• Major new customer additions not yet publicly announced (only reference I can find is vague reference to new customers by the CFO during the May earnings call).  Most recent 10-Q lists customers as Lowe’s, Walmart, Kroger, Safeway, Albertsons, Winn Dixie, H-E-B Grocery and Walgreens.  Primary research reveals that the company has unannounced new customer relationships with the following retailers, providing substantial upside to revenues and profits.  It is worth noting that many of these products have not yet been reviewed online by customers, illustrating the newness of the product listings (it also appears that many “reviews” are posted by short sellers of the stock as they have a Yahoo Message Board feel to them):
  • Bed Bath & Beyond: http://www.bedbathandbeyond.com/search/search.aspx/primo-water/?sstr=primo+water&grid=20&dim=1&nty=1&
  • BJ’s Wholesale Club: http://www.bjs.com/webapp/wcs/stores/servlet/Search?catalogId=10201&storeId=10201&langId=-1&pageSize=40&currentPage=1&searchKeywords=PRIMO+WATER&originalSearchKeywords=primo+water&x=0&y=0
  • Costco: http://www.costco.com/Common/Search.aspx?whse=BC&topnav=&search=primo%20water&N=0&Ntt=primo%20water&cm_re=1_en-_-Top_Left_Nav-_-Top_search&lang=en-US
  • Sam’s Club: http://www.samsclub.com/sams/shop/product.jsp?productId=prod2910111&searchTerm=primo%20water
  • Kmart/Sears:  http://www.kmart.com/primo-bottom-loading-bottled-water-dispenser/p-005W004289456000P?prdNo=1&blockNo=1&blockType=G1
  • Office Depot:  per store locater on company website
  • Food Lion:  per store locater on company website
  • Harris Teeter:  per store locater on company website

• 2012 Full Year Guidance
  • Net sales to increase 40-50% to a range of $118mm to $126mm
  • Adjusted EBITDA range to increase to $11mm to $13mm
  • GAAP EPS range of $(0.17) to $(0.20)
  • Non-GAAP pro forma fully-taxed EPS range of $0.03 to $0.08
  • Capex of $4.0-5.5mm
  • Estimates reflect non-recurring debt restructuring charges of $1.2mm incurred in Q1 & Q2, increased non-cash tax expense of $1.9mm, and $1.6mm of additional interest expense.
  • Water sales to increase 17-25% and dispenser sales to increase 40-50% compared with 2011
  • Flavorstation sales expected in the range of $15mm to $17mm
  • Total locations at year-end between 26,000 and 28,000 (long-term goal of 50,000-60,000)

• Near record short interest, which is approximately 14% of the float (removing insider shares and Camden Capital shares)

Risks:

• Loss of one or more significant customers.
• Poor execution, reduced future guidance.
• PRMW, certain of its related individuals and its underwriters (Stifel Nicolaus, BB&T, Janney Montgomery Scott) were named as defendants in a purported class action suit alleging misrepresentations of projected financial results relating to the IPO.  PRMW states it believes the lawsuit has no merit and plans to vigorously contest and defend against it.  While lawsuits are unpredictable by definition, an impartial reading of the IPO Prospectus’ Risk Factors section should provide comfort that the company fully disclosed the risks associated with its business, and the company has noted that it is insured for potential losses subject to limits.

Capital Structure & Valuation: 

• PRMW presents a fairly binary investment situation – if the company performs even modestly well, an investment today will result in a return of multiples of one’s original investment; if it does not perform or if the shareholder lawsuit is successful, shareholders have a risk of future dilution.
• If the company executes on its guidance and (gasp!) were to even surprise to the upside, then tremendous multiple expansion is likely to occur as (i) management credibility returns, (ii) investors refocus on the growth opportunity and razor/razorblade model and (iii) a substantial short squeeze ensues.  In that scenario, the hypothetical valuation targets below would likely prove far too low.

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.

Catalyst

• Execution on guidance, regaining management credibility
• Announcement of new customers additions
• Dismissal of purported class action suit
• Investor awareness of the situation
• Sale of the company to a financial or strategic buyer